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The equity premium in a production economy; A new perspective involving recursive utility

Aase, Knut K.
Working paper
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URI
http://hdl.handle.net/11250/281468
Date
2015-04-10
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  • Discussion papers (FOR) [593]
Abstract
We study a rational expectations' competitive equilibrium in a

production economy, i.e., a system of prices at which firms' profit

maximizing production decisions and individuals' preferred affordable

consumption choices equate supply and demand in every market. We

derive the equilibrium price of the firm and the equilibrium short

term interest rate, the optimal per capita consumption in society, as

well as the risk premium on equity. First a simple linear production

technology with constant coefficients is studied, then a more general

technology, and finally a general production economy with recursive

utility is analyzed by the use of the stochastic maximum principle.

While the two first models can not explain the empirics well using

conventional preferences, the latter model is found to be much more

promising in this regard. Wa also demonstrate a simple proof for the

ICAPM.
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FOR
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Discussion paper;15/15

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